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Why Some Bubbles Don’t Pop

Edward Chancellor has an interesting piece in the FT musing why some bubbles — like in Australian and Spanish real estate — haven’t got around to popping (completely).

Spain is perhaps the most perplexing of the recent housing bubbles. During the long boom, the Iberian peninsula was littered with speculative building projects. Construction peaked at a massive 18 per cent of GDP. The ratio of Spanish house prices to disposable income climbed from 3.8 times in the late 1990s to 7.7 times by 2007. Yet despite the severity of the financial crisis, which has driven unemployment to more than 20 per cent, the residential real estate market has proved remarkably resilient.

After doubling in the first half of the decade, Spanish house prices are down just 15 per cent in real terms. Spain’s house price to income ratio remains some 80 per cent above its long-term average. It is not clear why Spain’s house prices have proven so sticky. Housing transactions have collapsed and there have been suggestions official home price data do not reveal the true extent of the real estate carnage. The fact that Madrid provides generous mortgage support for the unemployed has also helped. Yet Spain cannot afford to support housing indefinitely.

These unburst housing bubbles remain a potential source of vulnerability to the global financial system. Inflated house prices also make it difficult for central banks to normalise interest rates when the time comes. Recent experience shows that government policies can stop housing bubbles from deflating. But they can’t make the problems disappear.